1 IPM is a more sophisticated model of the power se ctor developed by ICF that EPA uses for much of its analy sis of the power sector.

1 MEMORANDUM

TO: Docket

FROM: EPA, Clean Air Markets Division

SUBJECT: Analysis of the M argina l Cost of SO 2 and NOx Red uctions

DATE: January 28, 2004

Figur es VI -1 and VI -2 in the Ru le to Reduc e In

terstate Transpo rt of Fine Partic

ulate Matter and Ozone depict marginal cost curves tha t graph the marginal cost of the last ton of emission reductions needed to achieve various emission caps. Fig ure VI-1 includes mar

ginal costs of SO 2 reductions for caps from 10 million tons down to 1.5 million tons. Figure VI -2 includes marginal costs of NOx reductions for caps from 5 million tons down to 0.75 million tons. This memo provides detail explaining how these curves were develope d.

The curves were developed using the Technology

Retrofit and Updating Model (TRUM). TRUM is a mo del that se lects inve stment opti ons and dis patches gener ation to me et elec tricity demand. For simplicity this model was deve loped as a steady -state, single-region sprea dsheet model supported by Visual B asic for Applications (VBA) code. The model consists of a set of about six hundred “sample” generating units with vary ing characteristics. The mix of gener ation types and sizes was chosen to mirror , in general terms, the nationwide mix of capacities. The starting point for developing these sample g enerating units was the configura tion of the Inte grate d Planning

Model (I PM) 1 used by EPA. There fore, it relies on the same underly ing data. Each uni t is assume d to choose

emission c ontrol re

trofits, f uels, and gener ation lev els so as to maximize its own net profit in response to fuel prices, emission allowance prices, and prices of electri city for var ious dema

nd segme nts. Most of

the assum

ptions use d in TRUM for retrof it costs and removal efficie ncies, f uel pric es, and c osts for n ew units a re also b ased on I

PM inputs or outputs to the exten

t possible i

n a simplif

ied model

. Prices of fuels can be adjusted in the model in response to demand; price of electricity

by demand segment is set in the model so as to meet demand; and allowance prices can be adjusted to cause the industry to mee t given emission caps. The model allows each unit to make choices that maximize its net profit, taking prices and the actions of other units as unchanging parameters. Because the c hoices made by the

sample units will, in fact, have various effects on prices (and thus on the decisions made by other units) the model is run interactively until the interacting choices made by the units converge to a stable solution.2

In order to make the model r un quickly, it was not designe d to recognize the distinctions among electricity

demand regions and the transmission constraints that can keep the m separate. Thus, only one price of

electricity is dete

rmined for each demand segme nt for the entire set of sample plants. EPA and ICF have teste d TRUM against, the IPM and have found TRUM to be sufficiently ac curate to analy ze many environmental policies a t a “macro-level.”

In or der to de velop the marginal cost c

urve for SO 2 , the mode l was run i nterac tively

to determine the mar

ginal c ost of SO 2 reducti ons at var ious SO 2 emission levels. Because the NOx level ca n affect decision s about dis patch an d fuel use , which c an in turn impact the

marginal cost of SO 2 reductions, the model was run holding Nox emissions at a cap level of 2.3 million tons. This cap was chosen because it was within the rang e of policy options for NO x being considered, therefore it reasonably

approximated the affects that NOx regulations would have on dispatch and fuel choice. Becau se decis ions made to contro l SO 2 (e.g. dispatch , fuel swi tching) can also affec t NOx emissio ns, a con stant NOx e missions ca

p does not r

eprese nt a const ant marginal cost for NOx reductions across the entire curve. The f irst point on the curve, at ten million tons of SO 2 emitted, r

esults in a marginal cost for SO 2 of about $500 per ton. The marginal NOx curve was deve loped the

same way

, holding SO 2 emissions constant at just over 5 million tons. Similar to the way

that the N Ox cap was

chosen f or the SO 2 analy

sis, this ca

p was cho sen to re asonably approxima

te dispatc h and fue l choice s that cou ld be expec

ted due to SO 2 regula

tion. The f

irst point of the NOx curve, at five million tons of Nox emitted, results in a marginal costs for NOx of $500 per ton. Figure VI -1 and Figure VI -2 are included below. Just as the marginal cost of SO 2 control to meet a constant cap of 5.26 million tons changes as the NOx cap is cha nged, the marginal cost of

NOx to meet a

constant cap of 2. 3 million ton s also cha nges a s the SO 2 cap varies. All costs are in 1999$.

Figure VI-13 Figure VI-2